Creating a well-rounded financial portfolio is an important step in securing income during retirement. Understanding your specific financial situation, and how your financial numbers relate to your goals, is the first step in crafting an appropriate plan for retirement.
In today’s post we’re highlighting four important numbers to remember about retirement planning. While there are many uncertainties involved in making future projections these key figures can serve as a valuable guide in helping you plan for your future.
Save 15% of Yearly Income
As a general rule of thumb, if you save 15% of your current salary every year you will have a large nest egg saved up by the time you retire. In fact, a 2014 report by the Center for Retirement Research at Boston College found that most households saving 15% of their income will have enough in savings to retire at a comfortable level. However, this number is truly dependent on the age you begin saving for retirement and the amount you expect to have in savings at retirement. The later in life you start saving, the higher the percentage you should save each year. The sooner in life you begin saving, the less you will need to save each month due to compounded interest over time. To determine the amount of retirement savings you’ll need to save, use our next rule-of-thumb number.
The Magic of 25
The number 25 can be used as a good indicator to determine the amount you’ll need in savings before retiring. Start by determining your annual expenses and/or the amount of income you’ll need each year during retirement. Considerations include the following questions: will your mortgage be paid off? What bills and other monthly expenses will you need to cover? How much money do you want to have access to each year? Once you’ve taken into consideration your monthly expenses, calculate a total amount you’ll need each month to comfortably life. Take this amount and subtract estimated social security and pension benefits, then multiply that number by 25. This process calculates your total expenses, or ideal monthly income during retirement, for a 25 year period.
To put numbers to this, let’s assume you’ll want access to $80,000 per year in retirement and can anticipate receiving $20,000 per year in benefits. The difference you’ll have to make up for in savings each year is $60,000. Over a 25 year period, a realistic retirement window, you’ll need to have $1.5 million in savings ($60,000 x 25) to use during retirement. Of course, this number is largely dependent on the percentage of retirement savings you can withdraw each year. To determine that percentage, take a look at our next important number.
Withdrawals of 4% Yearly
As a general rule of thumb, 4% is the maximum percentage of assets that you should withdraw from retirement savings each year in order to make your nest egg last 25-30 years. Taking our previous example, if you have $1.5 million in retirement savings, withdrawing 4% the first year of retirement would give you access to $60,000 in yearly income. If you have $2 million in savings, 4% would give you access to $80,000 yearly. Having just $1 million in savings and using 4% of it would grant $40,000 per year in savings. An important question to ask then is: are you comfortable with the idea of living off this amount each year in retirement? If not, you need to utilize techniques to start saving more aggressively now.
Another consideration is adjusting for the rate of inflation. The current rate of inflation is 1.6%. Future inflation rates are hard to predict, over the past 30 years inflation has shifted dramatically; some years hitting highs of close to 7% and, in more recent years, hitting lows of -2%. Regardless, it’s important to factor in how inflation will affect withdrawing funds from your retirement nest egg. In today’s market, to maintain the spending power of 4% of your nest egg, you may need to account for rising inflation. For someone retiring today, withdrawing 4% of a $1.5 million nest egg, and receiving $60,000 will actually only have the spending power of $59,040. In order to get the full $60,000 in spending, you would want to withdraw 4.1%. Keep these numbers in mind as inflation continues to change over the next several years.
Stay on Track with 3.7
To get an idea of how you’re doing with retirement savings, consider the last number to remember: 3.7. This number is a tool to gauge how you’re currently doing in your retirement savings and is a tool presented by Charles Farrell’s book Your Money Ratios. The theory is that you should have 3.7 times the amount of your current salary saved by the age of 45, or halfway through your career. For example, if you currently make $150,000 per year, you should have $555,000 in savings. Someone making half that, $75,000 a year, should have $277,500 in retirement funds by the time they are 45.
It’s important to remember that each of these figures is calculated on retiring at the age of 65 and with the assumption that you will want to live on approximately 80% of your pre-retirement salary. Based on your individual circumstances, you may want to adjust these numbers either up or down. If you hope to live a higher quality of life during retirement, you may want to start saving a larger percentage of your yearly income. Alternately, many people plan to retire later than 65 or plan to live off less each year during retirement. Doing so may mean starting saving for retirement later or saving less each year is a workable option. As a general rule to remember, begin saving as soon and as much as you can.
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